Daiwa Shuns Sovereigns as Loss Worst Since ’10: Australia Credit

Jan. 9 (Bloomberg) -- Japan’s biggest investors are
favoring higher-yielding debt over government bonds in Australia
as improving economic prospects drive the worst losses for
sovereign notes in two years.

Daiwa SB Investments Ltd., which manages Asia’s biggest
debt fund dedicated to the nation, is bullish on Kangaroo bonds,
Aussie-dollar securities issued by foreign borrowers. Mizuho
Asset Management Co. and Mitsubishi UFJ Asset Management Co.,
overseeing more than $100 billion between them, are attracted to
state government bonds. Federal debt dropped the past week after
falling 0.6 percent last quarter, the most since the final three
months of 2010, Bank of America Merrill Lynch data show.

A rebound in iron ore prices and a pickup in manufacturing
in China, Australia’s largest trading partner, is buoying
investor confidence and curbing demand for safer assets in one
of only seven stable AAA sovereign markets. Kangaroo and state
debt gained 9 percent on average in 2012, versus 5.5 percent for
federal notes, according to Bank of America indexes. Japanese
fund gains were amplified by the Australian dollar’s 15 percent
rally against the yen.

“People are searching for more yield,” said Yoshisada
Ishide, who manages the $11 billion Daiwa SB Short-Term
Australian Dollar Bond Open Fund, which is also Asia’s second-biggest mutual fund. “Investors are still willing to take
credit risk.”

Buying KFW

Daiwa SB bought Kangaroo notes in November, said Ishide,
whose holdings include debt sold by German development lender
KFW and the European Investment Bank. He said he is
“underweight” federal notes.

Returns on an index of local-currency debt from foreign
issuers and Australia’s six states and two territories beat
sovereign notes last year by the most since 2009, led by a 21
percent advance for bonds of the European Bank for
Reconstruction and Development and a 14 percent gain for EIB.

The gauge, compiled by Bank of America, returned 24 percent
to Japanese investors after accounting for a tumble in the yen,
which slid 13 percent versus the Australian dollar last year. It
fetched 91.56 per so-called Aussie as of 12:26 p.m. in Sydney
after reaching 92.85 on Jan. 7, the weakest since September
2008.

Demand for Australian assets will persist as confidence
recovers, which may push the Aussie-yen rate toward 100, said
Ishide. He holds fewer government securities than would be
indicated by the gauges the fund uses to judge performance.

Yields Rising

Australia’s benchmark 10-year yield has increased after a
decline last year, rising to as high as 3.47 percent on Jan. 7,
the most since August. The rate was at 3.39 percent today, 152
basis points more than for similar-dated Treasuries.

The average discount on federal notes to Kangaroo and state
debt shrank to 69 basis points yesterday, matching the narrowest
since October 2011.

“This is a good time to start gradually switching back to
government bonds,” said Hideya Kubo, a senior money manager in
Tokyo at DIAM Co., which oversees the equivalent of $118
billion. “The spread between government bonds and other credit
products has become expensive.”

DIAM has been adding to government holdings in the past six
months and is aiming to reduce investments in Kangaroo bonds and
state government notes before the second half of 2013, he said.

Iron Ore

Prices for iron ore, Australia’s biggest commodity export,
climbed yesterday to the highest since October 2011. Government
figures last week showed Chinese manufacturing expanded for a
third-straight period in December and matched the fastest pace
in seven months.

Australia’s statistics bureau said today retail sales
unexpectedly declined in November after stalling the previous
month. A bigger-than-expected trade deficit and slumping
consumer confidence, amid a looming peak in resources
investment, are also supporting the case for lower borrowing
costs in the South Pacific nation.

Interest-rate swaps data compiled by Bloomberg show traders
show an 84 percent chance Reserve Bank Governor Glenn Stevens
will cut the overnight cash rate target to 2.75 percent or less
by June, which would take it to the lowest level in the central
bank’s 53-year history.

“There’s still a lot of yield pickup in state bonds,”
said Hideo Shimomura, who helps oversee the equivalent of $69
billion as Tokyo-based chief fund investor at Mitsubishi UFJ, a
unit of Japan’s largest publicly-traded bank. Government bonds
may benefit from rate cuts later in the year, he said.

Queensland Gains

Bonds by Queensland, the biggest issuer with about A$78
billion of outstanding debt, returned 9.4 percent last year
compared with an average 8.5 percent for a Bank of America gauge
tracking so-called semi-government notes. The state’s bonds
shrugged off a downgrade by Fitch Ratings to AA in September.

The spread between Queensland’s July 2023 security and
comparable sovereign bonds shrank to 107 basis points today from
124 on Nov. 29, according to prices from Australia & New Zealand
Banking Group Ltd.

Hiromasa Nakamura, a senior investor for Tokyo-based Mizuho
Asset, which oversees the equivalent of $38 billion and is part
of Japan’s third-biggest bank, said he is optimistic on state
bonds and so-called supranational notes issued by borrowers that
are backed by more than one government.

“Spreads are stable or gradually shrinking,” said
Nakamura, who counts notes by EIB and Queensland among his
favorites in the South Pacific nation. “The credit situation is
improving.”